Often dismissed as having outlived its usefulness, OPEC proved naysayers wrong by delivering a well-orchestrated production cut that, on the surface, involved not only its members, but also non-OPEC producing countries. The move drove crude prices higher, providing relief for OPEC’s most struggling members, as well as offering a helping hand to short-cycle U.S. unconventional producers.

Of course, the economics of a production cut offered a compelling reason in terms of generating a disproportionate jump in revenue from a relatively small drop in output. And setting aside geopolitics, the objective was far from herculean. OPEC’s goal was to accelerate the drawdown of global crude inventories over an initial six-month period—a target viewed as attainable in quarters, not years.

At one point Saudi Arabia’s energy minister, Khalid Al-Falih, reminded delegates that a viable alternative would to be to let crude prices gradually stabilize without an OPEC intervention, as global oil demand recovered. This was likely a bargaining tactic, but it set off a slide in crude prices as fears arose that talks would once again collapse, eight years after OPEC’s last successful round of negotiations.

What aspects of the deal helped West Texas Intermediate advance more than $6 per barrel (bbl) to $51.68/bbl in just three days?

Saudi Arabia, who with its Gulf allies would shoulder the heaviest burden of cuts, stipulated that an agreement must include several key conditions. These seem to have been met, noted Jefferies analyst Jason Gammel, in that terms of the agreement involved “collective action with equitable burden sharing and country-level allocations that provide credibility and transparency.”

Of the deal to lower OPEC output by 1.2 MMbbl/d, Saudi Arabia is to bear the brunt of the cuts, at 486,000 bbl/d. Its Gulf allies—United Arab Emirates, Kuwait and Qatar—are to cut their production collectively by 300,000 bbl/d. These reductions reflect a uniform decrease of slightly more than 4.5%, effective Jan. 1, and come from producing countries historically reliable in complying with OPEC cuts.

Similar cuts of around 4.5% were assigned to most, but not all, the other OPEC producers. Libya and Nigeria were exempt from cuts due to ongoing conflicts. Instead of basing Iran’s new production target on Octo-ber data, the agreement calculated a target using a 2005 high point in Iranian output. As a result, instead of a cut, Iran has room to raise production by 90,000 bbl/d.

“Iran may actually under-produce its target,” according to Tudor, Pickering, Holt & Co.

There was also give-and-take. Iraq argued against the use of October data, as reported by secondary sources, insisting it significantly underestimated its production. In the end, it acceded to a cut of 210,000 bbl/d from the October baseline, albeit with questions as to how strictly it may comply. Venezuela’s production cut was likely to happen—with or without an agreement—due to underinvestment.

A research report by Bernstein energy analysts estimated that, given the cuts announced by OPEC, the global crude market would shift into a deficit of 500,000 bbl/d in the first half of 2017, potentially rising to more than 1 MMbbl/d in the second half of the year. This would put upward pressure on oil prices, with Bernstein estimating $55/bbl to $60/bbl “in the short term” and $60/bbl and $70/bbl for 2017 and 2018.

An added incentive for OPEC action was how hedging strategies would be affected by drawing down bloated inventories. By normalizing inventory levels, prospects improve for the commodity curve to tilt toward backwardation (that is, forward prices lower than the prompt month). This takes away the ability of producers to hedge forward their future production at as attractive prices.

An area of less clarity is whether cuts by non-OPEC countries will occur as expected to total 600,000 bbl/d. A cut by Russia is placed at 300,000 bbl/d, without specifying a base-line. Other contributors are said to include Kazakhstan, Azerbaijan and Oman. Two non-OPEC participants were due to be added to the Ministerial Monitoring Committee, which is made up of Algeria, Kuwait and Venezuela, at an early December meeting in Doha.

“Time will tell whether this committee is successful or if OPEC regresses to past behavior,” said Jeff Quigley, analyst with Stratas Advisors.

What if non-OPEC cuts fail to materialize as advertised?

Jeff Currie, global head of commodities research at Goldman Sachs, noted a cut by OPEC on its own of 1.2 MMbbl/d would translate into OPEC output of 32.5 MMbbl/d. “Given historical compliance of 60% to 70%,” he said, “that gets you to 33 million barrels per day. And 33 million barrels per day is enough to normalize inventories by the end of the first half of 2017.”

Chris Sheehan can be reached at csheehan@hartenergy.com.

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